Download 235 ESTIMATING THE COST-VALUE RELATIONSHIP USING

The Annals of The "Ştefan cel Mare" University of Suceava. Fascicle of The Faculty of Economics and Public Administration
Vol. 10, No. 2(12), 2010
ESTIMATING THE COST-VALUE RELATIONSHIP USING INSTRUMENTS
OF MANAGEMENT ACCOUNTANCY
Professor PhD. Iuliana GEORGESCU
Professor PhD. Dorina BUDUGAN
PhD. Student Laura CRETU
Alexandru Ioan Cuza University of Iaşi, Romania
Abstract:
According to the Declaration of the International Federation of Accountants (IFAC, 1998), in the management
accounting evolution the period after 1995 is characterized by the interest in creating or producing value through
efficacious and efficient use of resources using the techniques whuch analyze the value inductors for the customer and
shareholders, through institutional innovation. In this context, the concern is to eliminate "non-value added activities",
that were characteristic for higher prices without increasing value for the customer. Awareness of this fact was
followed by a general mobilization to cover the development of integrative tools and models designed to manage costs
and value together, put them in bundles and carry out arbitrage between these two categories of elements: "the stakes is
to optimize the enterprise supply by adapting the capital that it invests at the same level that is the customer value of the
product".
Starting from the definition of value, we intend to begin to explore the concept of customer value and, in particular, we
will try to see if it differs from the price paid by the customer. Then we highlight the complexity of the concept of
customer, multiple customers and unstable customers, because this is the fact that makes measuring and ranking the
values that they perceive to be difficult, or in any case, relative. In the second part of the article we will look on the
problematic relationship between cost and value. To do this we will analyze the main management accounting methods
proposed to build this relationship, especially insisting on the target costing method and activity-based costing method.
Key words: cost, value, management accounting, customer, method
JEL Classification: M41
INTRODUCTION
An analysis of the evolution of management accountancy highlights the presence of several
stages. Thus, during the first stage (before 1950), the interest paid to the estimation of costs and to
the financial control was obvious, under the condition of applying the estimating techniques for
budgets, the accountancy of complete costs. During the second stage (until 1965), the interest
moved onto the reduction of resources used in the activity of a company, using the analysis of
processes and cost management techniques. As it can be implied, during the first two stages, the
performance of a company, especially the production results, were estimated on terms of the
financial results (deviations from the standard costs were the main indicator in the monitoring of the
production activity), whereas during the third stage, the estimation of the performance of the real
processes is integrated in monitoring systems. Recent trends in management accountancy highlight
the change from the accountancy based on costs to an accountancy based on value.
WHAT IS VALUE FROM THE ECONOMICAL POINT OF VIEW?
The definitions of value can be found in fields such as sciences, arts, economy and
philosophy. We shall not consider the definitions from sciences, arts or philosophy, but the ones
from economy as they can help us better understand the value of any asset or service for the
customer.
We have classified the definitions of value into two categories:
 definitions given by the traditional economists and
 neo-classical theories on value.
Economist Adam Smith gives the following definition for value: „the word value has two
different meanings: sometimes it expresses the utility of some particular object and, sometimes, the
power of purchasing other goods which the possession of that object conveys”. The first meaning
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The Annals of The "Ştefan cel Mare" University of Suceava. Fascicle of The Faculty of Economics and Public Administration
Vol. 10, No. 2(12), 2010
refers to the value in use, whereas the second to the value in exchange. For Marx utility is the
fundamental part of value, but it is reduced only to labour.
The value in exchange is, thus, “the price for which a commodity is exchanged for another”.
The value in use is given by the “utility of a commodity estimated either in an objective and general
manner, or in a subjective manner, consequently variable from one person to another. Hence, the
value in utility relates to needs, while the value in exchange requires relating to another commodity.
Whoever might handle the matter, Smith or Marx, utility motivates the economic productive
activity and represents the fundamental part of value, although its magnitude is determined by cost,
which allows an objective estimation.
For Jevons, considered the founder of the neo-classical school or the marginalist school of
economy, value does not count on costs, but on demand. It is determined by the marginal utility of
the commodity. Thus, for the supporters of the neo-classical theory, the value in utility depends on
the user, on the situation in which he is, on his preferences and it consequently has a subjective
character.
The first question which might me asked when talking about the management of the costvalue relationship is whether we know if we refer to the value in exchange or to the value in utility.
Actually, if we note the definition of value in utility given by the traditional economists, we could
consider that value equals the costs and the interest in research is excluded by itself. It seems that
we should take into account the value in exchange, if we want our research to be meaningful, value
which is expressed in monetary terms and could be equalled to price.
WHAT IS VALUE FOR THE CUSTOMER?
During the last two centuries, the term value has been used more and more often in the
business environment and the idea of creating value for the shareholder was greatly stressed.
Nevertheless, the popularity of the term did not come along with a clear explanation of its meaning
and it is still ambiguous, especially when people use the word value without mentioning whether it
refers to the value for the shareholder or the value for the other parties involved: employees,
customers, suppliers, other groups.
In order to acquire a full and adequate perspective on the critical areas in the activity of a
company, Robert S. Kaplan and David P. Morgan (1992) favour the necessity to take into
consideration several approaches for the notion of value, namely: the financial perspective
(equivalent to the value for the shareholders), the customer’s perspective (equivalent to the value
for the customers), the internal perspective and the learning perspective.
Leaving aside the value for the shareholder and the discussion about a possible convergence
of values for the different parties interested in the situation of a given entity, we shall focus on the
customer perspective and value. Actually, the researchers specialized in management accountancy
refer to it when they want to establish a relationship between the costs generated by the products
offered to the customers and the value created by the manufacturer for the same customers.
As the importance and understanding of the customer needs acquires a more and more active
role in any business stages and the strategies of many companies focus especially on customer
behaviour and the way in which customers operate, the definition of value from the customer
perspective is of high interest.
During the last decade, the customer has become the ”centre” of the business, starting a real
revolution in the planning activities of any business, a revolution which has its roots in the concept
of creating value for the customer. Creating value for the customer was and has been in the center
of the marketing strategies of many companies.
The customer, as it is defined by the literature in the field, is that person or entity which
benefits from the product or the service provided by a company. The consumer is defined as the
one who obtains goods and services for his own use, not to be resold or used in production.
Consumers are similar to a catalyst in the chain of value; their act of buying launches the flow of
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The Annals of The "Ştefan cel Mare" University of Suceava. Fascicle of The Faculty of Economics and Public Administration
Vol. 10, No. 2(12), 2010
activity of a company. Their demands and decision criteria are quite numerous and the cunstomer’s
methods of alloting value could be formal or informal.
The value created for the customers, in its most rudimentary form, is the difference between
the benefit acquired after consumption and the cost associated to the same product. Nevertheless,
nowadays consumers are much more educated and informed due to the information technologies
and consequently they tend to buy only those products which deserve the costs required for their
acquisition. In most cases, as presented in the literature in the field, the consumers’ perceptions on
price and value are considered the decisive factors in their behaviour.
The importance of the analysis of value created for the customer is continuously growing, as
the profit comes more and more from the creation and strenghtening of the relationship with
customers. The interest in the value created for the customer forces the management accountancy to
analyse not only the simple production costs, but also the price of the merchandise or of the service,
the maintenance costs, the research and development costs or the costs of elimination from
production.
Bradley T. Gale (1994; p.XX) proposes a model for defining the value perceived by the
customers as an adjustment of the price of each product or service depending on their quality,
determined by the customers’ opinion about the product or a service in relation to that of the
competitors.
The authors M. Larry Shillito and David J. DeMarle (1992; p. 11-14) bring powerful
arguments for value as a function of time. The moment a product enters a market, it has a strong
influence on the value perceived by the customer. In order to add more clarity to what we
understand by price, this characteristic should be defined again as property cost (maintenance cost
and withdrawal from the market).
In short, we could define the customer-perceived value as the price established by the
customer for a certain product or service depending on (a) the utility of the product in satisfying a
certain need, (b) the relative importance of the necessity to be satisfied, (c) availability of the
product when it is needed and (d) the property cost.
In many situations, the value created for the customer is confused with the price paid for the
products/service. The added-value is not estimated in contract terms, but the supplier must discover
it and make it known to the customers, in order to gain their trust.
TARGET COSTING
Managing the cost-value relationship is rather a new field in accounting research, although it
is known that during the 1980s the success of the Japanese companies was based on the solution
found for this issue. A great number of studies which synthesize the Japonese practices in
management accountancy ( Cooper 1995, Kato 1993, Tani 1995) rank target costing as one of the
methods which can establish a relationship between cost and value created for the customer.
Target costing is an approach used in management accountancy which helps in designing
products so that the lowest price possible could be reached, thus giving the opportunity of creating a
product according to the customers’ needs and demands at a target cost. The method of target
costing is greatly based on value engineering, offering an interdisciplinary examination of the
factors which affect the product cost with the purpose of finding a way to reach the standards of
quality and reliability for a target cost (Cooper 1995; p.352). We mention among the techniques
used in value engineering and implicitly in marketing, quality function deployment (QFD), down
analysis, quality and reliability testing, functional analysis and parametric cost estimation.
We consider target costing is a method which can establish a relationship between cost,
decided on internal level and price, decided on the market, on an external level. In order to support
our statement, we quote De Ronge (2000): “the production cost of the future product, named target
cost, is a priori determined and it is the result of the selling price imposed on the market and the
level of profit imposed by the long-term strategy of the company”. As a consequence, the definition
of customer value accepted by target costing is explicitly the selling price.
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The Annals of The "Ştefan cel Mare" University of Suceava. Fascicle of The Faculty of Economics and Public Administration
Vol. 10, No. 2(12), 2010
In his paper Horvarth (1995; p.76-77) considers that the optimum solution in cost
management and value would be obtained by applying the proportionality between costs and value
while referring to target costing he claims that “its purpose is to generate a sum of costs from all
parts of the product corresponding to the value given by the consumer”. Thus, target costing
becomes an efficient tool in maintaining the customer-created value, while costs are reduced.
Even though many researchers consider that target costing is a method of cutting costs, we
shall try to present an example which would highlight that this approach is also based on creating
value.
A factory producing furniture raw material signs a long-term contract with a manufacturer
of furniture for supermarkets. For this contract, the Marketing Department agreed on a very low
selling price. Thus, in order to obtain the greatest profit from this contract, there was created a cross
functional team with the mission to understand the customer needs and to find the production means
and methods and marketing strategies to create more value for the customer and diminish the costs.
One of the customer’s requests was to deliver boards of minimum 4m in length. This detail
was an impediment to the fulfilment of the contract obligations by the supplier as its position as
supplier for the local manufacturers made it difficult to offer every time a stock of boards of
minimum 4m.
The first solution to this problem was that the manufacturer could create a new product with
the length of 4m and to work especially for this customer. But, following the managerial
decision to adopt the target costing method, the marketing team had several meetings with the
customer in order to adapt the characteristics of the products and the company services to the
customer needs. The results of the discussions were the following:
 the customer is content with the just-in-time deliveries of the board kits, as the
manufacturing costs are reduced;
 the customer pays a higher price, as he receives kits instead of boards;
 many of the leftovers can be used by the supplier in sales, their cost being almost null.
This way, the customer reduced the costs of the stocks (the boards are no longer kept in
stock), for the materials and leftovers and the production time was also reduced, while the
manufacturer increased his incomes as a consequence of the higher price for the already cut kits.
In conclusion, the contribution of a target-costing approach in the management of the cost –
value relationship could be the following:
 on global level, it allows the link of the estimated selling price for any product to its price on
the market; we notice in this case that the notion of value is identified to that of the price;
 on analytical level, it contributes to the establishment of certain costs for the product parts,
attributes or functions, but there should be taken into account the fact that the parts should
be carefully created, so that the sum of costs would not have any relationship with the value
perceived by the customer.
ACTIVITY BASED COSTING
During the last years, there have been developed new approaches so that the information
offered by management accountancy could answer to the continuously changing demands of
management. Thus, in order to avoid the traditional hypotheses based on standard costs and the
analysis of the variations, there has been developed the Activity Based Costing (ABC) method,
which determines the costs of the resources for the activities it undertakes, offering a new vision on
costs.
As a consequence, the relationship between activities and costs is made clear by the two
fundamental principles of ABC, namely:
1. products “consume” activities, in other words, products require activities. The costs of the
activities are transferred to the product corresponding to the cost generators or creators;
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The Annals of The "Ştefan cel Mare" University of Suceava. Fascicle of The Faculty of Economics and Public Administration
Vol. 10, No. 2(12), 2010
2. activities (not products) consume resources or values which represent productive factors,
actually corresponding to the quantified expression of the monetary terms of these resources or
productive factors consumed by the activities.
In case the relationship between costs and value is unsure, the other two relationships, which
link the activities to costs and the activities to value, are the object of some causal links. So, “going
through the activities” we could link costs to value.
The activity could be defined as a specific mission or a group of tasks of the same type
undertaken in order to bring more value to the product manufacturing. (Oprea C., Carstea Gh; p.
261). If we were to resume to the two ABC principles, regardless of the dimension of the company,
we would have an unlimited set of activities and we could choose some of them. But the activities
thus identified might be more or less useful to identify the product cost, to make decisions or to
create value. Thus, in 1991, Lebas, after he had divided the company on account of activities, he
proposed the separation of value added activities from the non value added activities. Even more,
Mevellec, in 2000, brings together the value added activities which are similar into processes.
Starting from the premise and using the ABC method, Chauvey and Naro (2004) admit that it is
possible to link costs to value added for the customer, using activities and processes.
The value added activities are those activities which add value to the product or service for
which the customer is willing to pay. Thus, all the activities necessary to manufacture a product or
to improve its quality and reliability are value added activities. On the other hand, the non value
added activities are those activities which do not contribute with any kind of value to the final
product and are those activities for which the customer is not really willing to pay. Piling up
products and useless inspections on the production line are examples of activities which do not
create added value. These activities should be eliminated as much as possible.
Any ABC system offers information on the consumption of resources on products as well as
on customers. This information has the role to help management in decision making as regards the
design of the products, production technology, prices and range of products, decisions which might
have a long-term influence on the relationship of the company with its customers. We mention
here, as a competition advantage of this method the fact that the ABC method makes possible the
identification of profitability for each customer, by the separate estimation of two costs: cost per
product and cost per customer. Subtracting these costs from the selling price we obtain the profit
per customer, but also the corresponding position of products and services.
CONCLUSIONS
From the theoretical point of view, the answer to the question “Could management
accountancy control the relationship between cost and value?” is an affirmative one. But from the
practical point of view this thing seems difficult to accomplish as, traditionally, the management
accountant focuses on costs, in other words, on the internal management of the company, while the
management of customer value supposes being open to the market, even more, it requires an
expansion of the centres of interest and fields of activity. Management accountants are often
accused for not “creating value”, for hindering the other positions in creating value, for being
focused on cost reduction, but they can often find in the management accountancy tools for the
control of the cost – value relationship the means to stand for themselves and join even closer for
the strategic plans of the company.
A thorough knowledge of the studies made by marketing specialists would make possible a
better use of their results in the company strategies to develop new products. For exemple,
understanding the fact that these values are not only marginal, but they are adding and multiplying
and so on, could have an influence on the development of the target cost approach.
The creation of value starts from the customer. All activities that the companies are doing
for quality should focus on customer needs and demands. But they cannot be aware of their future
needs, therefore companies have to anticipate, innovate and create new values for original products,
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services and processes. It is vital to understand the value made available for the customers by the
company, at present as well as in the future.
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